Educational Articles

What are the Advantages of Mutual Funds

Robert Adamski
| November 09, 2009

There are many advantages to mutual funds, and the consensus acknowledges at least four main ones:

The first is professional management. Whether we work for a company or for ourselves, the increasing demands of our jobs have reduced the amount of free time we have to manage our personal investments. In the past 30 years, more individuals are managing self-directed retirement accounts, as traditional pension plans are no longer offered by employers. Also, as investment volatility increases, we are required to make much quicker decisions regarding our investments and our retirement accounts, in order to preserve our capital and increase our assets. The days of buying and holding shares of a handful of well-known companies are over. Professional fund managers now have the responsibility of deciding which of the thousands of securities available should be selected for inclusion in a fund. They do this, using the extensive stock analysis of their in-house research and trading staff. They must also decide when to sell securities. Also, many funds provide their managers with permission to use options and other hedge strategies to hopefully preserve gains and reduce losses. Such strategies require much skill, knowledge, and time.

Second is the benefit of diversification. A mutual fund can own hundreds, maybe thousands, of issues. This diversification greatly reduces the risk of a large loss due to problems in a particular company, industry, or asset class. With a relatively small investment in selected mutual funds, a subscriber can achieve material levels of diversification. Many individuals, even if they have the money to diversify, can’t find the time and energy to increase their diversification using individual stocks.

A third benefit is liquidity. Shares of mutual funds can be easily bought and sold any business day, the price determined by the closing net asset value that day. Each individual stock requires a separate order. Moreover, while many stocks can be bought and sold readily, others aren’t widely traded. Thus, it could take much time and effort to buy or sell a position. Also, if you want to increase or reduce your equity exposure, you might want to sell or buy the same percentage of each stock you own. Selling or buying a fund could accomplish the same with one transaction.

A fourth benefit is convenience. Buying a fund is as simple as buying an individual stock through a broker. However, the convenience can continue following the initial purchase. Such features as automatic reinvestment of dividends and capital gains distributions, programs for regular additional investments and for systematic withdrawals, and telephone exchanges among different funds within the same family make investing in funds an attractive investment alternative. Funds also provide you with the detail of how much long and short-term capital gains you have earned, and how much in the way of dividends you have received from each stock in the fund throughout the year, helping to simplify your tax preparation.